Pennies Today Can Mean Dollars Tomorrow

Local financial professionals talk tax diversification and retirement strategies.

What if you could use money that has been taxed today to create tax-free income in the future? What if there was a strategy to get tax-deferred accumulation no matter what your level of income? This is where a sound diversification strategy comes in.

“The list of customizable ways to diversify your approach to tax planning is vast and complex,” says Jason Bezou, founder and president of New Orleans-based Bezou Financial Planning Group. “That is why it’s important to make tax diversification part of the plan that you implement and monitor over your life and through the ever-changing tax laws.”

Antoine Pedeaux, a financial services professional at New York Life in New Orleans, says today’s highly intricate income tax system is very efficient at taxing almost every type of income stream, but at very different rates.

“Some types of income are taxed very heavily every year while others are taxed at lower rates,” he says. “Without careful planning, sources of tax-free future income might never be created.

“Your strategy could eventually return more than you put in, without tax, while leaving your family a legacy,” he says. “You can create the dollars needed in the future for pennies on the dollar today.”

Kimberly Tara, a certified public accountant and tax coach with the Tara CPA Firm in New Orleans, says many clients don’t realize what they are leaving on the table, which is why it’s so important to work with a professional.

“Tax planning is always about more than one strategy or idea, which is why it’s imperative to work with a qualified professional who specializes in tax planning and strategy, not just compliance (preparation),” she says. “We want to take a holistic approach that encompasses business and personal goals as well, not just tax savings goals. We dig deep to really get to know our clients and make sure that all of our strategies fit their situation.”

Most financial experts agree that working with a team of financial professionals who complement each other’s strength and specializations is always a savvy idea.

Bezou notes that while everyone loves the idea of tax deferral or tax-free, there are pros and cons for each tax benefit.

For example, tax deferral can build up and cause a huge taxable event at an inconvenient time.

“That’s why it’s important to have enough pre-taxed money invested or set aside in a way that is accessible without penalty or loss potential and then consider investing more aggressively in the tax-deferred funds that you will likely hold for longer and take out slowly over time to supplement other income sources during retirement,” he says. “That safe money sitting in a bank account might not make much money, but it affords you the guts to withstand the ups and downs of other retirement funds that you don’t plan on needing or using for a long time.”

Tips for Individuals
Pedeaux says the perfect retirement plan for individuals would consist of three features: contributions that are tax deductible, tax-deferred accumulation and distributions that are tax free.

“Unfortunately, this perfect plan does not exist,” he says. “Like most things in life, you can have two out of the three. A traditional IRA allows for tax deductible (pre-tax) contributions and tax-deferred accumulation, but distributions at retirement are taxed at the individual’s ordinary income tax rate. A ROTH IRA is the opposite; funding contributions are not tax deductible (post-tax); however, the accumulation is still tax deferred and distributions at retirement are not taxed as income.”

The IRS sets a maximum limit of $6,000 in contributions annually that can be placed inside an IRA or a ROTH IRA, and individuals with an annual earned income of $137,000 are ineligible to make any ROTH contributions in that year.

“Keep in mind, opening a retirement account is making a deal with the IRS,” Pedeaux says. “In exchange for the favorable tax status of these accounts, the IRS will not allow the investor access to the retirement funds until he or she reaches the age of 59 and a half. Any funds withdrawn prior to this age will incur a 10% penalty, and ordinary income tax will need to be paid on the amount withdrawn at that time.”

For those considering retiring before 65 who need healthcare prior to becoming Medicare eligible, Bezou offers some advice.

“If your taxable income remains low enough, you could benefit from thousands of dollars in subsidies and tax benefits that are only available to lower-income families,” he says. “So, keep income low during that time. Perhaps that’s one reason to spend down money from a savings account rather than starting Social Security early or beginning to pull from IRAs or deferred annuities.”

A lesser-known vehicle for tax-favorable retirement planning is a Cash Value Whole Life Insurance policy. The premiums paid into these policies are “post-tax” and not deductible. The growth of the cash value inside the policy is similarly tax-deferred, and the cash value can be accessed for retirement income-tax free through policy loans.

“Furthermore, there are no annual contribution limits, and there are no age limits for accessing the cash value,” Pedeaux says. “Additionally, as a life insurance policy, the death benefit passes to the owner’s beneficiaries income-tax free.”

Tara cautions clients to make sure withholding rates are adequate for any year-end tax liability.

“We’ve seen many clients caught off guard since the beginning of 2018,” she says. “Re-evaluating entity selection would be our top planning tip given the tax reform we’re currently experiencing—what may have worked before may no longer be the best option.”

Tip for Business Owners
Owning a business presents individuals with both opportunities and challenges not faced by employees. Among those is that while many employees have access to a retirement plan at their work, business owners are generally responsible for managing their own retirement.

“Business owners need strategies to reposition some of that post-tax money out of the tax cycle and put it in a 0% tax bracket where it won’t ever be taxed again,” Pedeaux says. “A ROTH IRA could be a suitable vehicle, but many business owners exceed the $137,000 income limit, eliminating that option. For high-income business owners, Cash Value Life Insurance is often an ideal instrument to permanently remove funds from the tax cycle and create a tax-free stream of income during retirement.”


Tax-Free is the Way to Be

If you’re interested in future tax-free income, you need to ask yourself the following questions:

Do you have multiple income streams?

Do you know which taxes apply to them?

Do you have any income that is growing without taxation, any tax-free income?

When was the last time your CPA discussed creating sources of tax-free income in future years, or have

they only focused on reducing this year’s income tax burden?

Do you have time to find the tax laws that allow for tax-free future income?

Do you know how to apply them?

Do you know if you qualify for these strategies?

If you’ve answered a lot in the negative, it may be time to call a CPA.